Our Global Head of Thematic and Fixed Income Research joins our
Chief Fixed Income Strategist to discuss the recent market
volatility and how it impacts investor positioning within fixed
income.
----- Transcript -----
Zezas: Welcome to Thoughts on the Market.
I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income
and Thematic Research.
Vishy: And I am Vishy Tirupattur, Morgan
Stanley's Chief Fixed Income Strategist.
Zezas: And on this episode of Thoughts on
the Market, we'll talk about the recent market volatility and
what it means for fixed income investors.
It's Wednesday, August 7th at 10am in New York.
Vishy, on yesterday's show, you discussed the recent growth of
money market funds. But today I want to talk about a topic that's
top of mind for investors trying to make sense of recent market
volatility. For starters, what do you think tipped off these big
moves across global markets?
Vishy: Mike, a confluence of factors
contributed to the volatility that we've seen in the last six or
seven trading sessions. To be clear, in the last few weeks, there
have been some downside surprises in incoming data. They were
capped off by last Friday's US employment report that came in
soft across the board. In combination, that raised questions on
the soft-landing thesis that had been baked into market prices,
where valuations were already pretty stretched. And this one came
after a hawkish hike by Bank of Japan just two days prior.
While Morgan Stanley economists were expecting it, this hike was
far from consensus going in. So, what this means is that this
could lead to a greater divergence of monetary policy between the
Fed and the Bank of Japan. That is, investors perceiving that the
Fed may need to cut more and sooner, and that Bank of Japan may
need to hike more; in both cases, more than expected.
As you know, when negative surprises show up together, volatility
follows.
Zezas: Got it. And so last week's soft US
employment data raises the question of whether the Fed's
overtightened and the US economy might be weaker than expected.
So, from where you sit, how does this concern impact fixed income
assets?
Vishy: To be clear, this is really not our
base case. Our economists expect US economy to slow, but not fall
off the cliff. Last Friday's data do point to some slowing, on
the margin more slowing than market consensus as well as our
economists expected. And really what this means is the markets
are likely to challenge our soft-landing hypothesis until some
good data emerge. And that could take some time. This means
recent weakness in spread products is warranted, and especially
given tight starting levels.
Zezas: So, it seems in the coming days and
maybe even weeks, the path for total fixed income market returns
is likely to be lower as the market adjusts to a weaker growth
outlook. What areas of fixed income do you think are best
positioned to weather this transition and why?
Vishy: We really need more data to confirm
or push back on the soft-landing hypothesis. That said, fears of
growth challenges will likely build in expectations for more Fed
cuts. And that is good for duration through government bonds.
Zezas: And conversely, what segments of
fixed income are most exposed to risk?
Vishy: In one way or the other, all spread
products are exposed. In my mind, the US corporate credit market
recession risks are least priced into high yield single B bonds,
where valuations are rich, and positioning is stretched.
Zezas: So clearly the recent market
volatility has affected global markets, not just the US and
Japan. So, what are you seeing in other markets? And are there
any surprises there?
Vishy: Emerging market credit. In emerging
market credit, investment grade sovereign bonds will likely
outperform high yield bonds, causing us to close our preference
for high yield versus investment grade. It is too soon to
completely flip our view and turn bearish on the overall emerging
market credit index.
We do see a combination of emerging market single name CDSs as an
attractive hedge. South Africa, Colombia, Mexico, for example.
Zezas: So finally, where do we go from
here? Do you think it's worth buying the dip?
Vishy: Our message overall is that while
there have been significant moves, it is not yet the time to buy
on dips.
Zezas: Well, Vishy, thanks for taking the
time to talk.
Vishy: Great speaking with you, Mike.
Zezas: And as a reminder, if you enjoy
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